Is black box high frequency trading actually good for the markets?

After Lord Myners recently called for the impact on the markets of high frequency trading to be investigated, some new research claims to bust the HFT myths.

Flying in the face of popular belief, the Capital Markets Cooperative Research Centre (CMCRC) (the Australian independent academic centre for capital market research), found that HFT can actually benefit global markets and performance.

Professor Alex Frino, PhD, and his team of researchers looked at market data from SGX; NASDAQ; Euronext Paris, ASX and LSE and examined the impact of HFT on volatility and the provision of liquidity.

The results were quite surprising. Not only did their research show that HFT added real liquidity into the market it also tended to calm volatility, not exaggerate it.

“At the beginning of the project I spoke extensively to the buy-side to gather their views on HFT. Those views were fairly negative, so I expected to find negative effects, but to my surprise that wasn’t the case at all.” Said Professor Frino.

They found that the liquidity supplied by HFT, far from being ‘artificial’ as many claim, was as real as liquidity from any other source and used in exactly the same way. “We found that overall they are net providers of liquidity – and this liquidity is as readily used by other market participants as any other kind.” Professor Frino said.

Tokyo Stock Exchange

With volatility the Professor Frino’s team found that the way that HFT algorithms work tended to smooth out prices. “We find no evidence of a positive relationship between HFT and price volatility. To the contrary the data suggests that rather than exacerbating price volatility as many have claimed, HFTs may actually play a role in decreasing excessive price volatility. Part of this function is the way HFT algorithms identify trading opportunities – they’re built to recognise when prices are abnormally high or low, and their response to this naturally pushes prices back towards equilibrium.” Said the professor.

The image is from Wikipedia and Wikimedia Commons user Chris 73 and is freely available at http://commons.wikimedia.org/wiki/File:Tokyo_stock_exchange.jpg under the creative commons cc-by-sa 3.0 license.

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